TYPES OF LEASE

Lease transaction is categorized on the basis of:

 Transferability of risks and rewards of ownership.

 Number of parties involved in the transaction.

 Domicile of equipment manufacturer, lessor, and

lessee.
Based on these factors lease is broadly classified into:
 Finance Lease

 Operating Lease
A. FINANCE LEASE

 A finance lease is a method of equipment financing.

 It’s a non-cancellable lease contract for a long term or
medium term.
 A lessor extends credit to a lessee and transfers all
responsibilities of ownership such as maintenance,
insurance and taxes to a lessee for a period of time equal to
the economic life of the asset.
 A lessee may either purchase the asset or return it to a
lessor at the termination of the lease contract.
 The lease rentals are fixed in such a way as to recover the
marginal cost of debt financing.
 Characteristics of financial lease

 A lessee selects the equipment and a lessor. A lessor may

recommend alternate equipment but the final decision is
with a lessee.

 A lessee uses the equipment for the purpose of business.

Equipment leasing generally excludes consumer finance and
hire purchase activities.

 The equipment is purchased by a lessor.

 A lessor keeps the title to the equipment throughout the

tenure.
 A lessee has the exclusive right to use the equipment.
The third party does not have any right to it.

 lessee and lessor both should agree for a sub leasing

arrangement.

 Finance lease is non cancellable. This means that if a

lessee terminates the lease either voluntarily or by
default he has to pay a sum of penalty as
compensation.

 Loss of account of obsolesce of the equipment is to be

borne by a lessee and he is responsible for the repair,
maintenance and insurance of the equipment.
 Working of the finance lease

 A lessee takes the decision regarding the asset required and the
manufacture or the supplier. He also decides about his other requirements
like the design, specifications, the price, warranties, and term of delivery,
installation and servicing.

 A lessee gives the quote regarding the equipment to a lessor.

 If the quote is acceptable, a lessee is required to submit an application in

the prescribed format. A soft copy of lease application is also enclosed
along with it.

 A lessor processes the application and a letter of offer is issued

immediately after sanction.
 A lessee and lessor sign a lease agreement.

 The purchase order is placed on the supplier at the request of the

lessee. It can either be a fresh one incorporating the terms
suggested by a lessee or he place a novation of an earlier purchase
order.

 After the purchase order is accepted by the supplier, disbursement

is made at the request of a lessee.

 The advance already paid by a lessee to a supplier is reimbursement

on production of necessary supporting documents. Further
payments are released directly to the supplier at the request of the
lessee.

 On installation of the asset capitalization of the asset is done and

rental commence.
B.OPERATING LEASE

 Any lease other than a financial lease is an operating lease.

 It’s a simple agreement between the owner of the equipment (lessor) and
the end user (lessee) which provides for the exclusive use of the
equipment by a lessee for a monthly fee.

 It’s an agreement to rent the equipment to be used for a fixed period.

 In an operating lease a user (lessee) will have to return the equipment to

the lessor at the end of the lease term without an obligation for a residual
value.

 Operating lease generally remains in effect for a short to medium period.

 Operating lease agreements are usually for a certain number of months

or year with an option to extend the number of months or period upon
mutual agreement.
FEATURES OF OPERATING LEASE

 Short term lease.(lease period <useful life of the asset)

 Lease cancelled at a short notice by the lessee.

 Lessee has the option of renewing the lease after the expiry
of lease period.
 Lessor is responsible for maintenance, insurance and taxes
of the asset.
 Higher risk to the lessor.

 Higher lease rent to the lessee.

Operating lease is common to the equipments which require

expert technical staff for maintenance and are exposed to
technological developments.
EG: Computers, Vehicles, Communication Systems
 Working of the operating lease
 An agreement is executed between lessee and lessor for
deployment of equipment for a definite period and agreed
monthly rentals and other associated terms and conditions.
 A lessor has to deploy equipment as per a lessee’s
requirement.
 Equipment deployment can be for a short or medium term.

 Pre-determined monthly rentals are payable by lessee for

use of the equipment.
 A lessor is responsible for the repair and maintenance,
operational crew, insurance etc.
 On expiry of the agreement lessee has to return the
equipment in good condition and lessor has to take back the
equipment.
 Advantages of operating lease
 It improves the profitability of the business.( profits are
generated by the use of the equipment without
acquiring ownership).
 It enable lessee to diversify his business by utilizing the
available financial resources which would otherwise
have been utilized for acquisition of the particular
equipment.
 It enables one to hedge against equipment obsolescence.
Leasing makes the lessee more comfortable as there is
no need to worry about resale of equipment.
 A lessor is generally responsible for the insurance,
operation and maintenance, repair, operating crew etc.
 Equipment deployed is based as per the users need
either short or long term.

 It allows for replacement of the equipment as and

when needed. (There is scope for selecting multiple
equipments.)

 Helps lessee to accurately forecast the income

against expenses. (Lease equipment cost is
predictable and can be more easily measured
against the income that the new equipment is
expected to generate.)

 It provides the lessee a shield against inflation.

DIFFERENCE BETWEEN FINANCE LEASE AND OPERATING LEASE

  FACTOR FINANCE LEASE OPERATING LEASE

Number Of Lessee Single Lessee Several Lessees
Amortization Of Full Cost Is Recovered Full Cost Is Recovered
Cost Of Leased From One Lessee From Many Lessees
Assets

Maintenance With The Lessor With The Lessee

Responsibility

Revocation Of Non-Cancellable In Cancelled By Short Notice

Lease The Primary Period By The Lessee

Period Of Lease Long Term .Lease Short Term. Lease

Period =Fair Value Of Period<Useful Life Of The
Asset Asset
TYPES OF FINANCE LEASE

ED LEASE
LEVERAG
SALES AND
LEASE BACK
AND DIRECT
LEASE

FINANCE
LEASE
TYPES

CLOSE ENDED
ENDED LEASE
AND OPEN
LEASE
INTERNATIONAL
DOMESTIC AND
LEVERAGED LEASE
 Mainly used to provide finance for equipment assets which require a
huge capital outlay.
 Assets leased here are large ticket items which include aero planes,
satellites, ships, power generation plant etc.
 Here the assets are of high cost therefore finance requirement is also
high.
SALE AND LEASE BACK
 In this agreement a company sells an asset to another
party who in turn leases it back to the company.
 The company sells an asset at the present market value.

 By this type of transaction the company is able to use

its financial resources for other purposes in the place of
low yielding fixed assets. However the company has the
obligation to pay periodic rentals.
 This type of lease is beneficial to the lessee and lessor.

 Lessor gets the benefits due to depreciation

 Lessee gets immediate cash inflow and his liquidity

position improves.
 Company having short term liquidity crisis adopt this
type of leasing.
DIRECT LEASE
 It can be defined as any lease transaction which is not
a sale and leaseback transaction.
 A direct lease may be arranged either by supplier or
manufacturer directly or through leasing company.
 Direct lease are of 2 types. Bipartite lease and
Tripartite lease.
 A Bipartite lease consists of two parties, the
equipment supplier-cum-lessor and the lessee.
 A Tripartite lease involves 3 different parties. An
equipment supplier, a lessor and a lessee. Most of the
equipment lease transaction fall under this category.
DOMESTIC LEASE
 Here all the parties to the transaction, namely the
equipment supplier, the lessor and lessee are
domiciled in the same country.
INTERNATIONAL LEASE
 Here all the parties to the transaction, namely the
equipment supplier, the lessor and lessee are
domiciled in different countries.
CLOSE ENDED LEASE
 A closed lease is arranged on a net basis and the
equipment is released to the lessor in the end.
 Loss of residual value is with the lessor.

 
OPEN ENDED LEASE
 Open end lease are generally net lease where the title of
the equipment passes to the lessee upon exercising the
purchase option or upon payment of guaranteed residuals.
 A part of the risk of the loss of residual value is passed to
the lessee.
 The possibility of ownership is also open to the lessee.
OTHER TYPES OF LEASE
 Straight lease
it require the lessee firm to pay lease rentals over the
expected service life of the asset and does not provide
for any modifications to the terms and conditions of the
basic lease.
 Modified lease

it provides several options to the lessee during a lease

period.
e.g. : the option of terminating the lease may be
provided by either purchasing the asset or returning the
same.
 Floating rental rate lease contracts
 frequent changes in the interest rates in the last few years has led
to this type of lease contract.
 here lease rentals are reduced or increased according to the
borrowing rates of the lessor.

 Import lease
 here both the lessee and the lessor are residing in the same
country but the equipment supplier belongs to different country.
 the lessor first imports the equipment and lease it to the lessee

 Cross boarder leave

 when a lessor–leases an equipment to a lessee who is not falling in
the jurisdiction of the lessors country then the lease is called cross
boarder lease.
 REASONS FOR THE GROWTH OF
INDIAN LEASING

 Rapid industrial growth

 Availability of funds

 Less legal requirements

 Tax laws